06 Direct Participation Programs

Question 1

All of the following partnerships would be appropriate for an investor seeking immediate cash flow except:

A. Raw land
B. Existing properties
C. Oil & gas income
D. Equipment leasing

Answer 1

A. Raw land

Rationale:
There’s no income stream from raw land.

Question 2

All of the following are benefits to limited partners except:

A. Depreciation
B. Appreciation
C. Depreciation recapture
D. Accelerated depreciation

Answer 2

C. Depreciation recapture

Rationale:
The word recapture is linked to your friends and mine at the IRS. If the IRS recaptures prior tax benefits, this is not a good thing for the investor.

Question 3

If the offering circular or prospectus used in conjunction
with a DPP offering identifies only 60% of the assets, this is referred to as a:

A. Shell offering
B. Blind pool offering
C. Special purpose entity offering
D. Shelf offering

Answer 3

B. Blind pool offering

Rationale:
The pool of assets is being kept in the dark, so to speak. A blind pool of assets. As in, we don’t want other land speculators or oil developers to see where we’re going next. The test might want you to conclude that a “blind pool raw land offering” would be pretty darned high-risk. You’re investing your money and you don’t even know where the land is.

Question 4

An oil and gas DPP shares all of the following characteristics with a real estate DPP except:

A. Proportionate share of expenses/losses
B. Depletion
C. Depreciation
D. Limited liability

Answer 4

B. Depletion

Rationale:
Only natural resources, like oil & gas, get depleted. When you sell a barrel of your oil, you’re depleting your assets, so you take a subtraction called a “depletion allowance” to reduce your taxable income.

Question 5

Losses from DPP’s may be used to offset:

A. Ordinary income
B. None of the choices listed
C. Passive income
D. Portfolio income

Answer 5

C. Passive income

Rationale:
If you don’t have passive income, you probably aren’t looking for DPP “tax shelter.” Passive income comes from real estate rentals or other DPP’s, and that’s the only income you can deduct against with DPP losses.

Question 6

A customer would purchase a limited partnership that buys oil and gas production for all of the following benefits except:

A. Depletion allowances
B. Depreciation
C. Liquidity
D. Economic viability

Answer 6

C. Liquidity

Rationale:
There isn’t any liquidity in DPP’s. You buy in, you’re in.

Question 7

Your customer’s real estate limited partnership reports income of $1,000,000, management expenses of $100,000, maintenance expenses of $100,000, and depreciation of $900,000. What is the profit or loss?

A. $1,000,000 profit
B. $100,000 loss
C. $200,000 loss
D. $1,000,000 loss

Answer 7

B. $100,000 loss

Rationale:
Just take the income and subtract the three expenses/paper deductions. You start with a million, then subtract $1.1 million, for a paper loss of $100,000.

Question 8

Your customer has significant passive income that she would like to shelter. You would most likely recommend which type of limited partnership?

A. Raw land
B. Oil & gas exploration
C. Existing properties
D. Oil & gas income

Answer 8

B. Oil & gas exploration

Rationale:
Oil/gas exploration involve lots of upfront intangible drilling costs (IDC’s) such as the geological survey and labor. Those IDC’s will not be offset with income of any kind for quite some time, so this rich person will get her tax shelter and everybody’s happy.

Question 9

Which of the following documents discloses to the public what the partnership does, who the partners are, the address of the business, etc.?

A. Subscription agreement
B. Certificate of limited partnership
C. Partnership agreement
D. Blind pool affidavit

Answer 9

B. Certificate of limited partnership

Rationale:
Just one more thing for you to remember.

Question 10

Which of the following would be last in line in a limited partnership liquidation?

A. IRS
B. General partner
C. Limited partner
D. Secured creditors

Answer 10

B. General partner

Rationale:
The GP has a big, demanding role to play. He’s got the management responsibility, personal liability to creditors, a fiduciary responsibility to the LP’s, and if the whole thing goes belly up, he’s the last one to get paid.

Question 11

Limited partners are least likely to:

A. Receive depreciation deductions
B. Utilize partnership democracy
C. Provide investment capital
D. Decide which assets to sell

Answer 11

D. Decide which assets to sell

Rationale:
That’s the role of the GP, and if the LP starts making management decisions like that, he can lose his limited liability status. Which is bad.

Question 12

General partners may do which of the following?

A. Compete with the partnership
B. Lend money to the partnership
C. Commingle personal and partnership assets
D. Borrow money from the partnership

Answer 12

B. Lend money to the partnership

Rationale:
Can’t do the first three—memorize that.

Question 13

Which of the following partnerships is most speculative?

A. Existing properties
B. Developmental oil & gas program
C. Exploratory oil & gas program
D. Oil & gas income program

Answer 13

C. Exploratory oil & gas program

Rationale:
Exploring for oil is the riskiest for oil & gas programs. Raw land is the most speculative for real estate programs. If we’re doing a “development” program, that means we’re drilling for oil/natural gas in an area where others have found it. If we buy “income” programs, we’re immediately getting cash flow from the oil/gas being sold already, so the risk goes down in that order exploratory, developmental, income. And, so does the reward.

Question 14

The General Partner bears the capitalized or tangible costs for an oil-drilling program, while the Limited Partners bear the IDC’s. This sharing arrangement is known as:

A. Inconsequential
B. Functional allocation
C. Abusive
D. Reversionary assignment

Answer 14

B. Functional allocation

Rationale:
The costs/expenses are being allocated by function—functional allocation.

Question 15

If the IRS determines that the tax shelter provided through a limited partnership is abusive, they may do all of the following except:

A. Charge general partners with intent to defraud
B. Charge limited partners with intent to defraud
C Charge all partners with penalties, back taxes plus interest
D. Sentence partners to life Imprisonment

Answer 15

D. Sentence partners to life Imprisonment

Rationale:
Life imprisonment?

Question 16

Real estate DPP’s and REIT share all of the following characteristics except:

A. Pass-through of income
B. Real estate exposure
C. Limited liability for investors
D. Pass-through of losses

Answer 16

D. Pass-through of losses

Rationale:
The REIT is a share of stock, period. In a real estate DPP, you’re a partner, and you get a share of the Income and expenses of the business.

Question 17

Which of the following partnerships offers the highest risk/reward ratio?

A. Historic rehabilitation
B. Oil & gas exploration
C. Oil & gas production
D. Existing properties

Answer 17

B. Oil & gas exploration

Rationale:
Exploring for oil is the riskiest for oil & gas programs. Raw land is the most speculative for real estate programs.

Question 18

Which of the following is used to determine all benefits offered potentially by an investment in a limited partnership?

A. Internal rate of return
B. Sharpe ratio
C. Matched speculative algorithmic curvature
D. Short interest ratio

Answer 18

A. Internal rate of return

Rationale:
Memorize it, just in case.

Question 19

Which of the following is the least liquid investment opportunity?

A. Mutual funds
B. Common stock
C. Convertible debentures
D. Direct participation programs

Answer 19

D. Direct participation programs

Rationale:
DPPs are generally illiquid. In the offering documents, the syndicator/GP provides a target date for liquidation and also some background on how any previous partnerships panned out in terms of meeting that target. This gives you an idea of how illiquid theinvestments are. No one can even tell you when you’ll be able to sell, let alone what the thing would be worth two or three years down the road.

Question 20

Which of the following documents authorizes the GP to
manage the partnership?

A. Subscription agreement
B. Certificate of limited partnership
C. Partnership agreement
D. General partner authorization sheet

Answer 20

C. Partnership agreement

Rationale:
The partners agree to be partners and to let the GP run the business through the partnership agreement.

Question 21

Your customer might invest in a limited partnership for all the following benefits except:

A. Tax shelter
B. Economic viability
C. Limited liability
D. Liquidity

Answer 21

D. Liquidity

Rationale:
DPP’s have little or no liquidity.

Question 22

If the syndicator of a DPP is selling limited partnership interests for $100,000, he/she may keep how much in syndication fees?

A. $9,000.00
B. $25,000.00
C. $10,000.00
D. $8,500.00

Answer 22

C. $10,000.00

Rationale:
10% syndication fees, yet another number for you to memorize.

Question 23

Which of the following parties would be paid ahead of your client a limited partner in an equipment-leasing program, should the partnership go through a bankruptcy liquidation proceeding?

A. Unsecured Creditors
B. None of the choices listed
C. General Partner
D. Limited Partners

Answer 23

A. Unsecured Creditors

Rationale:
Not because they’re “unsecured,” but because they’re creditors. Creditors get paid first secured, then unsecured. Then, the LP’s. The GP is last in line, which is probably a good thing. If he were up for work and running the partnership.

Question 24

Similarities between real estate limited partnerships and real estate investment trusts include all of the following except:

A. Flow through of losses
B. Entity not taxed if 90% or more of net income is distribute
C. New construction or existing real estate may be the operational objective
D. Centralized management

Answer 24

A. Flow through of losses

Rationale:
Only the partnership (DPP) offers a flow-through of losses for tax purposes to the owners.

Question 25

The General Partner would file an amendment to the certificate of limited partnership for all of the following reasons except:

A. Sharing arrangements have been altered
B. An increase in contributions from a general partner
C. The partnership suffers a net loss for the fiscal year
D. An increase in contributions from a limited partner

Answer 25

C. The partnership suffers a net loss for the fiscal year

Rationale:
Year-to-year operations would be reported to the limited partners, not added to the certificate of limited partnership on file with the state regulators.

Question 26

Intangible drilling costs in an oil & gas limited partnership would not include which of the following?

A. Labor
B. Casing
C. Land surveys
D. Fuel

Answer 26

B. Casing

Rationale:
Casing is equipment. IDC’s are everything involved with drilling besides the cost of equipment (pumps, casing, i.e.).

Question 27

Primary objectives of a DPP investor for purposes of suitability would generally not include:

A. Long-termcapitalgains
B. Tax deductions
C. Tax credits
D. Short-term capital gains

Answer 27

D. Short-term capital gains

Rationale:
LP’s generally want to defer the income and capital gains as long as possible by way of receiving a share of deductions and/or tax credits now. Short-term capital gains could be sought in the options market, but DPP investments are long-term and illiquid.

Question 28

One of your investors is a limited partner in an oil & gas exploration concern. She has inquired if you know the name of the document that the GP would have filed with the state attesting to the formation of the partnership. This document is called the:

A. Subscription agreement
B. Certificate of limited partnership
C. Minutes of the annual board meeting
D. Private placement memorandum

Answer 28

B. Certificate of limited partnership

Rationale:
The subscription agreement and private placement memorandum (PPM) provide disclosure to the investors, the LPs. The partnership files a “certificate of limited partnership” with the state notifying them that they exist and what they’re up to.

Question 29

Intangible drilling costs include all of the following in an
exploratory oil program except:

A. Fuel
B. Geological survey
C. Pumps
D. Labor

Answer 29

C. Pumps

Rationale:
Equipment is tangible. IDCs include expenses that are paid
by the partnership for services and consumable items (fuel).

Question 30

Regarding direct participation programs, which of the following is an accurate statement?

A. Real estate limited partnerships and REITS are essentially the same
B. Real estate and oil exploration programs both offer depletion allowances
C. Real estate and oil exploration programs both offer depreciation
D. Tax credits are the main reason to invest in a direct participation program

Answer 30

C. Real estate and oil exploration programs both offer depreciation

Rationale:
It’s not easy to weed out three false statements, but the exam will expect you to do exactly that. Keep looking for things that are blatantly false or do not hold up to further scrutiny. REITS are not the same as DPPs. There is no depletion in a real estate program. Tax credits are an advantage of specific types of partnerships, but not partnerships in general.

Question 31

Which of the following is an accurate statement concerning the offering of limited partnership interests?

A. Limited partnership interests must be offered via a private placement
B. Institutional investors are disqualified from investing in oil & gas DPPs
C. Registered representatives must obtain verification of their investors’ net worth when selling limited partnership interests
D. Limited partnership interests are available to any US citizen, regardless of net worth

Answer 31

C. Registered representatives must obtain verification of their investors’ net worth when selling limited partnership interests

Rationale:
Many DPPs are sold through private placements, but not all of them. The LPs have to indicate their net worth, as these offerings are generally open only to investors who can stand to lose a few million dollars really fast.

Question 32

An investor purchases a limited partnership interest for $250,000, giving him a 5% interest. The partnership develops 5 of the planned 25 townhouse units but can not keep up with loan payments. The properties are foreclosed and sold by the lending institution for $1 million less than the balance owed. Therefore, the investor will receive:

A. 5% of the $250,000 investment
B. $250,000 only
C. Nothing
D. 5% of the proceeds from the foreclosure auction

Answer 32

C. Nothing

Rationale:
The secured creditors always get paid first. Since the secured creditors didn’t even recover the money owed, nobody else will see a dime here.

Question 33

The main tax advantage received by a limited partner in an oil income program is:

A. Depletion 
B. Tax credits
C. Depreciation
D. Disintermediation


Answer 33

A. Depletion

Rationale:
When oil is sold, the accountants take a subtraction from revenue that provides tax advantages. This is called a depletion allowance. Disintermediation has to do with investor moving out of safe, low-yielding debt securities into long-term, higher-yielding securities.

Question 34

When a limited partnership is liquidated, the last party to receive any proceeds would be the:

A. Unsecured lenders
B. Secured lenders
C. Limited partners
D. General partners

Answer 34

D. General partners

Rationale:
The GP is last in line at a liquidation.

Question 35

One of your investing clients wants tax shelter, has low liquidity needs but also wants a lower-risk direct participation program in which to invest. You should recommend:

A. That he purchase an oil income program interest
B. That he purchase an oil exploration program interest
C. That he invest in bank CDs instead
D. That he purchase broad-based index options instead

Answer 35

A. That he purchase an oil income program interest

Rationale:
Oil income (production) is much safer than drilling for oil (exploratory, developmental). If there's already oil coming out of the ground, that takes a lot of the mystery out of the equation, right?

Question 36

Jerry is a client who wants to invest in long-term capital appreciation opportunities but specifically states he is not interested in current cash flow. Which of the following programs would be most suitable for Jerry?

A. New construction program
B. Oil income program
C. Existing properties program
D. Raw land program

Answer 36

D. Raw land program

Rationale:
If you chose “oil INCOME” program, you have to start listening to investors more carefully. Raw land may appreciate in value (or not), but it will not provide the following: cash flow, depreciation, depletion.

Question 37

Warren Weeks purchased a limited partnership interest five years ago for $100,000. Warren is then asked to loan the partnership $20,000. If the partnership goes into bankruptcy, Warren will be considered a:

A. Limited partner for the $100,000, a creditor for the $20,000
B. Debtor-in-possession
C. Fiduciary to the partnership
D. Limited partner for both the $100,000 and the $20,000

Answer 37

A. Limited partner for the $100,000, a creditor for the $20,000

Rationale:
He’s an LP in terms of his capital contribution. Then, he made a loan, which makes him a creditor.

Question 38

An investor is solicited for the purchase of a raw land limited partnership interest by a broker- dealer through Jeremy Sullivan, one of the firm’s registered representatives. Turns out, the GP did not hold proper title to nearly half the acreage specified in the offering circular, and when oil is later discovered on the property, with all profits going to outside parties connected to the GP through other ventures, the LPs sue for breach of offering  fiduciary duty. Which of the following best addresses this situation?

A. Limited partnership interests are generally too risky for all but institutional investors
B. The LPs may not sue the GP if they invested pursuant to a “blind pool offering”
C. The broker-dealer and the registered rep are shielded from any lawsuits
D. Jeremy could be pursued under Code of Procedure and Code of Arbitration

Answer 38

D. Jeremy could be pursued under Code of Procedure and Code of Arbitration

Rationale:
The LPs can definitely vote to sue the GP for fraud/breach of fiduciary duty. If his offering document claimed the partnership would own X amount of land, when it really only held title to Y amount of land . . . fraud. The investment could be considered unsuitable, so we have to assume Jeremy could be disciplined and taken to arbitration if the investor is convinced he was mistreated, duped, etc.

Question 39

All of the following enjoy “limited liability” except:

A. General partner of a limited partnership
B. Owner of junk bonds
C. Holder of an equity straddle
D. Owner of a small-cap, speculative growth stock

Answer 39

A. General partner of a limited partnership

Rationale:
The GP is a fiduciary, with unlimited liability. The other folks can only lose they amount they’re foolish enough to invest.

Question 40

A real estate limited partnership is currently using accelerated cost recovery systems (accelerated depreciation schedules). Therefore:

A. Earnings will be overstated in early years and in later years
B. Net income will be converted to a net loss
C. Earnings will be understated in early years, overstated in later years
D. Earnings will be overstated in early years, understated in later years

Answer 40

C. Earnings will be understated in early years, overstated in later years

Rationale:
if the partnership takes a $10,00 purchase of equipment and then chooses to depreciate a bigger, disproportionate amount of that in early years, net income/earnings will be understated in early years . .. but in later years, there will be less to depreciate/subtract from revenue. With straight-line depreciation, the subtractions would be even year after year.

Question 41

A partnership that leases airplanes to smaller, regional airlines would not have which of the following available?

A. Accelerated cost recovery systems
B. Depletion
C. Risk of recapture
D. Depreciation

Answer 41

B. Depletion

Rationale:
They might or might not have acclerated cost recovery systems available-depends on the ever-changing tax code. But there’s no way they can take depletion allowances, since they’re not in the natural resources business.

Question 42

The person who distributes new limited partnership interests is known in Series Sevenland as the:

A. Distributor
B. Master limited partner
C. Syndicator
D. Limited partner

Answer 42

C. Syndicator

Rationale:
They syndicate the interests and may keep a syndication fee of 10%.

Question 43

A limited partnership organized shelter in the early years of operation. What is the name given for the situation in which the partnership’s income begins to exceed available deductions?

A. Point of diminishing returns
B. Recapture
C. Tax shelter
D. Crossover point

Answer 43

D. Crossover point

Rationale:
The tax shelter is over-dar the luck, they’re starting to show a profit! The crossover point, in which they cross over from being in the red to being in the black.

Question 44

Which of the following accurately states the purpose of depreciation?

A. To spread the cost of an asset over its useful life
B. To compensate oil and gas producing entities for depleting their reserves
C. To allow the LPs to show a loss in the early years of operation
D. To increase reported net income

Answer 44

A. To spread the cost of an asset over its useful life

Rationale:
Depreciation spreads the cost of an asset over its useful life or its “recovery period.” If a business turns some cash into a printing press, it doesn’t consume that printing press in one year-rather, it spreads that cost over several years. This does not automatically lead to a net loss, although it does reduce net income by definition.

Question 45

One of your investing clients is excited about becoming a limited partner in one of Donald Trump’s many real estate ventures. He wants to know at what point he will be accepted as a limited partner. You would accurately inform him that:

A. He will be accepted as an LP when the GP signs the subscription agreement
B. He will be accepted as an LP when the check deposited by the GP has cleared
C. He will be accepted as an LP when the partnership receives IRS approval
D. He will be accepted as an LP when the GP deposits the check

Answer 45

A. He will be accepted as an LP when the GP signs the subscription agreement

Rationale:
He signs the subscription agreement and is accepted as an LP when the GP signs the agreement to let him into the program.

Question 46

A general partner would engage in a conflict of interest to the LPs if he did all of the following except:

A. Borrowed money from the partnership
B. Inserted a no-compete fee of $1,000 into the partnership agreement
C. Lent money to the partnership at prevailing interest rates
D. Sold property that he owned to the partnership

Answer 46

C. Lent money to the partnership at prevailing interest rates

Rationale:
The GP can’t compete with the partnership, period, so if he charged the LPs to not compete . . . well, we saw two former haunchos of the Chicago Sun-Times end up in jail for such shenaningans. Google: Conrad Black, F. David Radler. The GP can’t possibly sell his own property to the partnership and give the partnership the best deal. He also can’t borrow from the partnership.

Question 47

An investor would not purchase a limited partnership interest for a developmental (step-out) oil program for which of the following reasons?

A. Tax shelter
B. Recapture provisions
C. Intangible drilling costs
D. Depletion allowance

Answer 47

B. Recapture provisions

Rationale:
Recapture is a reality of the limited partnership investment, but not a positive thing. Basically, the IRS makes the LPs add back to income some of the prior tax deductions they enjoyed.

Question 48

A developmental oil program is set up under a functional allocation in which the GP bears capitalized (tangible) costs and the LPs receive a proportionate share of intangible drilling costs. All of the following are examples of intangible drilling costs except:

A. Cost of the equipment
B. Trucking charges to bring equipment to the drilling site
C. Cost of the geological survey
D. Labor costs

Answer 48

A. Cost of the equipment

Rationale:
Equipment (rig, casing, etc.) is tangible. The other costs (expenses, really) are intangible. Think of labor and services as intangible-they leave no tangible thing behind.

Question 49

Rory Gogan is an LP in a real estate partnership. His cost basis is $75,000, which includes a $25,000 share of a recourse note. If the partnership fails, Rory may claim a maximum of what amount as a passive loss?

A. $50,000
B. $25,000
C. $75,000
D. $100,000

Answer 49

C. $75,000

Rationale:
Read carefully. Did you add $25,000 to his basis? Why?

Question 50

Accurate statements of limited partnerships include which of the following?

A. Limited partners are fiduciaries to the other LPs
B. Limited partnerships must have at least two limited partners
C. Limited partnerships are not taxed
D. Limited partnerships must have only one general partner

Answer 50

C. Limited partnerships are not taxed

Rationale:
The limited partnership is not taxed as an entity-rather, the income and expenses flow through directly to the owners. There must be at least 1 GP and 1 LP. Beyond that, no numerical rules exist.

Question 51

When a limited partner sells his interest, he will be taxed on the difference between proceeds of the sale and:

A. His adjusted basis
B. His accreted basis
C. The amortization schedule
D. His original basis

Answer 51

A. His adjusted basis

Rationale:
Cost basis adjusts as time goes on due to deductions taken, more capital contributions made, recourse notes signed, etc.

Question 52

In the first year of operation, an oil or gas drilling program would generate most of the available tax shelter through which of the following?

A. Depletion
B. Geological survey
C. Depreciation
D. Intangible drilling costs

Answer 52

D. Intangible drilling costs

Rationale:
There may be zero depletion-if they haven’t started producing oil yet. Use logic—if the geological survey is PART of the “IDCs,” than the IDCs have to be bigger than any one part, right?